Capital Is Key for Deutsche Bank in Face of New Rules

By Joe Ortiz

[This article was originally published by Dow Jones Investment Banker. To find out more about the service please visit: http://www.dowjones/banker]

A 1.2 percentage point fall in Deutsche Bank‘s core Tier 1 asset ratio to 7.5% at the end of the first quarter raises concerns that the German banking giant is a little underweight as, in common with other international banks, it faces a regulatory onslaught likely to curb its investment banking returns.

Associated Press

Deutsche Bank CEO Josef Ackermann

Deutsche’s first-quarter results exceeded expectations and made CEO Josef Ackermann’s target of reaching a pretax profit of €10 billion by 2011 look more credible. That said, the first-quarter net income of €1.8 billion on net revenues of €9 billion was massively biased toward investment banking which made a pretax profit of €2.6 billion compared with €1.3 billion in the same period last year on revenue of €6 billion, up from €4.3 billion last year.

Whether or not this performance is sustainable in purely business terms, all other things being equal, the problem for Deutsche is that it looks unlikely to be sustainable after the politicians and regulators have had their say. The bank says it’s too soon to speculate about the effects of regulation. This may be true but that hasn’t stopped analysts making forecasts which don’t make happy reading.

As the Basel III quantitative impact study is completed, it is starting to dawn that if the proposals go forward as originally framed the effect could be to “deliver a wholly punitive capital charge,” as an analyst note from Credit Suisse put it last month.

Deutsche penciled in a €50 billion rise in risk weighted assets – some think it could be as much as €60 billion of Counterparty Credit Risk – but Credit Suisse said the rules in Basel III for Credit Valuation Adjustments could add as much again to Risk Weighted Assets (RWAs).

The deterioration of Deutsche’s capital ratios in the period was caused by the acquisition of Sal. Oppenheim, which reduced capital by the purchase price of €1.3 billion and added €17 billion to RWAs, and by changes in securitization rules. The ratio will be hit again in the second quarter by the consolidation of assets bought from ABN Amro in the Netherlands.

If changing regulations were to add €100 billion to RWAs, this would take them to just shy of €400 billion and take the bank’s total Tier 1 ratio from 11.2% now, to 8.4%, and the core Tier 1 ratio to a miserly 5.6%. Deutsche added €1.8 billion of income to capital in the first quarter and, if that were sustainable, would add €7.2 billion to capital over a year. That would take the core ratio back up to 7.4%.

However, few observers think the first-quarter performance of Deutsche’s fixed income business can be sustained and Deutsche executives, while saying that the second quarter had started well, were keen to dampen expectations that the results at the start of the year could be extrapolated. There’s no doubt that Deutsche did a good job in the first three months but its capital position isn’t determined by that alone.

On top of regulatory threats and problems of sustainability, Deutsche is also facing the need to raise capital if it wants to fully takeover Deutsche Postbank, of which it controls nearly 30% and has an option to acquire the rest. Analysts say this could require a 10% rights issue to raise just above €3 billion. No wonder that CFO Stefan Krause told analysts on Tuesday that the bank is in no hurry to complete the purchase.

But purchases like the Sal. Oppenheim, ABN Amro and Postbank are necessary for the long term if Deutsche is to diversify its earnings and reduce its dependency on the beleaguered investment banking segment.

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